Inflation: The Stealth Tax

How will deficits which abound from the U.S. Federal Government’s coffers down to those of the smallest municipality be reconciled?  One can quickly surmise the glimmer in a politician’s eye when the short-term benefits of inflation’s sultry siren falls on his or her ears amidst budgets plagued by rampant Federal spending and tax cuts.  People in power know deficit spending is important business.  For instance, Thomas found that Alan Greenspan’s visits to the White House under Bush have quadrupled since Bush replaced Clinton (deficit spending has characterized the Bush administration). [1]  As with most economic data, inflation figures can be sliced and diced to appear to support just about whatever one’s particular agenda entails.

“Inflation is a stealth tax and has a very efficient built-in collection scheme… everyone holding Dollars is affected and everyone’s purchasing power is diminished, therefore the collection of this ‘tax’ is 100%efficient. And to make it even better, there is no paperwork to fill out, no check to send in, no harassing telephone calls from the tax collector, and the government can continue to print all of the dollars it wants so it can continue a free spending policy.”   –  Stephen Williams in “Cycle Pros”

What’s an investor to do?  “Occasionally successful investing requires inactivity,” Buffett imparted to his devoted flock. [2]   Further, Hanson observes ‘man is hard-wired to appreciate perceived success and feel comfortable with consensus’. [3]   So although inflation may offer modest short-term appeal to politicians, it is easily explained why investors would shrink from investing new dollars given inflation’s less appealing longer-term effect; namely a demonstrable ability to destroy an economy.    But…ah…Grasshopper, attend us when we say that which is bad for the U.S. economy may cloud potential good for U.S. companies.  In the event you happened to take up residence on another planet for the past five years or so, let us acquaint you with the trend of outsourcing as one example of corporations’ productivity.  Outsourcing is a company’s use of resources in a location outside of its native country; usually as a means of increasing profit through a more cost competitive climate.
With that said, investors should naturally focus on sectors which have demonstrated profit potential in the face of inflation.  “When it comes to money,” Kilgore advises, “it’s always better to bet on results than potential.” [4]  If history is any guide to the present and if inflation accelerates, the energy sector might reward investors.  Can you say $3 per gallon of gasoline?
At the same time, investors should not overlook that if Japan can continue to produce improvements in its economy, U.S. companies may take their outsourced, competitively priced wares abroad.  Don’t forget healthcare.  Recall, many believe the Japanese and European economies pulled the U.S. out of the recessions of 1981-82 and 1990-91 respectively.  So do not discount the possibility of surprises befalling the investment community in the coming quarters even though the specter of inflation may startle one as would a B-2 stealth bomber parked outside one’s window.

Let the Data Do the Talking

An unanticipated and unwelcome development which makes investment analysis more difficult AND less meaningful has emerged: recent changes in economic data released by and compiled by the U.S. government make those reports released after 2003 less meaningful.  Data from early 2004 to present is now littered with statistical adjustments.  For instance, earlier this year, employment and unemployment reporting calculations were altered so future reports now have little relevance to any similar report released prior to January 2, 2004.  Furthermore, in the first week of June the Federal Reserve revised all of its money supply data back to 1998.  Money supply analysis for the past six years was made irrelevant in one release of a report.
Does this mean economic reports are any less useful than in the past?  Heavens no.  But it does mean perception, not reality, will bear the weight of meaningful economic analysis for the foreseeable future.  After all it’s not as though economic reporting was an exact science to begin with.  Recently, Lussier ridiculed so-called economic “experts” and their opinions.  He measured Wall Street experts’ forecasts.  The results from data from 1982 to 2003: [5]
Their One year nominal GDP forecasts were off by 102%.
Their Two-year nominal GDP forecasts were off by 109%.
Their One-year inflation targets were off by 29%.
Their Two-year inflation targets were off by 41%.
Therefore it comes as no surprise that researchers find that consensus is typically useless for handicapping future market pricing and it is the contrarian who may have the best approach to making money in the markets.  We were moved to lessen our dependence on the options markets for future price modeling as the option market’s contribution to price discovery has been found to be as low as 17% on average. [6]   The need to refine one’s forecasting techniques cannot be understated as research finds that macroeconomic factors are unable to explain momentum profits after simple methodological adjustments to take account of microstructure concerns. [7]
Forecasting changes as the world changes.  “China has 4,813 cement plants, more than the rest of the world combined, and they still don’t have enough” Wiggin writes.  “Projects like the Three Gorges Dam and Beijing Olympics forced China to gobble up 55% of the world’s supply of cement, 40% of its steel, and 25% of its aluminum.” [8]  We see on this side of the Pacific that GMAC [GM’s financing arm] now “contributes 2 out of every 3 dollars of GM’s profits…with more than half of the financing profits completely unrelated to the auto business” Bonner reports. [9]  Naisbitt wrote of the U.S. morphing from a manufacturing economy to an information economy in his 1970s best-seller Megatrends.  Today, that book would assuredly address the financial economy.  Kasriel calculated “between 1960 and 1984…banks, brokerage firms, finance companies and the like accounted for 12% to 22.5% of total corporate profits”. In 2002, the financial sector contribution reached 44.75%…”[10]

The Jeweler’s Eye

In the next 60 days, America will be covered with reports from the Democratic and the Republican National Conventions, with one sometimes feeling the biggest question might not be how each team of nominees will perform during the revelry.  Instead, the question lurks: will terrorists strike the convention?  If not at the conventions, where will they strike next?
We have arrived at a conclusion which will someday be deemed correct or incorrect that terrorism has been institutionalized.  Concern is everywhere and dwells in every bosom across the country.  No one is safe.
From an investment perspective, we have taken an initiative over the past quarter to calibrate our applications to analyze securities as though 9-11 did not occur.  For example, we attempted to derive estimates of how much Coca-Cola might have been sold sans disruptions post 9-11.  How many Seniors postponed elective surgeries?  How many vacationers postponed trips to foreign countries due to fear of the terror bogeyman?  We do so not in denial of that God forsaken tragedy that affected thousands of our countrymen.  It must also be stated that we recognize our techniques are rudimentary if not outright inaccurate.  Nevertheless, should another major terror attack be undertaken on U.S. soil, God forbid, we believe the average American (and for our focus: the average American investor) would proceed through the SARA healing process (Shock, Anger, Rejection, Acceptance) more quickly than any of us did after the collapse of the World Trade Center.  In a recent interview with Berkowitz, Buckley stated there is no way the threat posed by extremist and non-consolidated Muslim terrorists compares with that of, say, the threat posed for over forty years by the Soviet Union and their 3,500 nuclear warheads bristling from launching pads aimed at targets in the U.S.11   It is for these reasons that we believe investors may be surprised as growth continues in certain areas of the economy.
Of course, fortunes may be made or lost in determining which sectors may experience growth.  We offer one for your consideration: caring for the health of an aging population.
Hopefully it comes as little surprise that Health care now constitutes almost 15 percent of the United States’ gross domestic product – or double what it was 30 years ago, according to the Washington Post.  In a report released in April, NACS reported “The per-person cost of health care in the United States has risen to $5,440. That amount is double what is spent in European countries.”[12]
It may come as a surprise the extent which health care is a global business.  The New England Journal of Medicine (NEJM) detailed the composition of the International Medical Graduate list with Indian-born graduates constituting over 20% of the whole.[13]
Though conventional wisdom may view cardiovascular disease as being assimilated with Americans, the NEJM report illustrated the growth in the incidence of cardiovascular disease in non-Western cultures in the next 15 years. [14] 
The same report depicted Cholesterol levels to have increased over 20% during the past 20 years in a study conducted in Beijing. [15]
And do not forget diabetes.  “An estimated 170 million people worldwide suffer from diabetes, which is a leading risk factor for cardiovascular disease” Mendoza wrote. “The majority of people with diabetes – roughly 65% — will suffer a heart attack or stroke, a rate that is up to four times higher than in adults without diabetes.” [16]
The world’s getting older.  All people will require more care to their health.  Some people will have the money to pay for that care.  Other people will rely on alternate means  to pay for their care.


1 K. Thomas, University of Pennsylvania Wharton School, Christian Science Monitor, May 2004
2 E. Fry, Daily Reckoning, April 20, 2004
3 V. Hanson, National Review Online, “Our Reptilian Brains,” May 28, 2004
4 T. Kilgore, CBS Marketwatch, May 24, 2004 
5   per Pierre Lussier, Investment Information Provider
6 per Chakravarty, Gueln and Mayhew, “Informed Trading in Stock and Option Markets,”  Journal of Finance, June 2004, p. 1235
7 per Cooper, Gutierrez Jr. and Hameed, “Market States and Momentum,”  Journal of Finance, June 2004, p. 1345
8 per A. Wiggin, Daily Reckoning, June 2, 2004
9 per B. Bonner, Daily Reckoning, June 2, 2004
10 per P. Kasriel, May 6, 2004
11 per W. Buckley Jr. in interview with Jeff Berkowitz
12 per NACS, April 12, 2004
13 per New England Journal of Medicine, June 10, 2004
14  ibid.
15  ibid.
16 per Dr. R. Mendoza, Biotech Report, June 14, 2004